Courtesy: The Daily Star (Dhaka). 29 November, 2022
The focus of this writeup is banks, which historically have contributed positively to our development. In recent times, several problems and challenges have appeared in the banking domain, which include, among other things, mismanagement, corruption, lack of transparency and accountability and, above all, lack of good governance. The challenges are manifold, including regulatory governance.
This article will mainly address several challenges facing the banking sector in generating internal shocks for the economy.
Loan scams
The Hallmark, Crescent Group, AnonTex and Bismillah Group financial scams involving state-owned Janata Bank, Sonali Bank and Basic Bank, and recently unearthed loan scams in Islami Bank Bangladesh, the largest private commercial bank, have demonstrated cracks in the governance and management of these banks. From the Board of Directors to the management group to the lower-level officials, these banks have not shown any sign of good governance, transparency and accountability.
The Crescent Group swindled Tk 35.72 billion that came to light around 2015. While the Bismillah Group conned about Tk 11 billion from Janata Bank in 2012, AnonTex embezzled Tk 55.08 billion from the same bank in the 2019 financial year. The Hallmark Group misappropriated about Tk 35 billion from Sonali Bank in 2013 and BASIC Bank lost more than Tk 60 billion by way of fictitious loans extended by the bank’s board.
In the case of the of Islami Bank, the S Alam Group, which controls the Islami Bank, took out about Tk 300 billion in loans, an amount far beyond Tk 2.15 billion that the group is entitled to. The S Alam Group also obtained large loans using fictious and unethical means from First Security Islami Bank Limited, and Social Islami Bank Limited. The loan scams have proven the adage, “the best way to rob a bank is to own one”. It is also believed that these banks have extended the loans on political consideration.
A disturbing fact is that these irregularities have permeated to private commercial banks as well. Furthermore, it is alleged that political connections are at the core of financial scams. As The New York Times observed, “Banking in Bangladesh is beholden to the politicians”. The series of loan scams took place since 2009 and can be traced back to politically connected individuals.
Bank governance: International norms
The International Accounting Services Board (IASB) under the Bank for International Settlements (BIS) in Basel, Switzerland, has provided three major norms namely Basel I, Basel II and Basel III. Basel I of 1988 required that banks and financial institutions have sufficient capital adequacy, which was originally 8% of risk-weighted assets (RWA). Later on, it was raised to 10% for banks, including those in Bangladesh. There are some banks in the country whose requisite capital adequacy falls short of the norm. Basel I set up a mechanical, non-market-oriented measurement of capital adequacy which could not take care of fundamental risks, e.g., operational risk and market risk. Basel II, introduced in 2004, took care of the different types of risks for financial intermediaries (i.e., banks) as well as the supervisory review process for the management of banks.
The global community realised the inadequacies of Basel I and Basel II during the global financial crisis of 2007. Basel III was designed in 2013 to strengthen the capital framework of banks and to give more emphasis on equity capital (Tier-1, core capital); second, to ensure global liquidity; third, to highlight systemic risks as well as mitigation measures that address the risks. Two major aspects regarding liquidity are Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR). The Bangladesh Bank (BB) has taken measures to implement Basel-III liquidity ratios.
The disclosure of banks in their financial reports is prepared following the International Accounting Standards-30 (IAS-30). This has been replaced by International Financial Reporting Standards (IFRS-7). According to this format the financial disclosure is more logical, which means that banks now face higher risk in investment and management of capital. If the required standard is followed, then depositors and clients of the banks and the general people will not face any loss. Besides IAS-30, there are also IAS-32, IAS-39 and IFRS-9, which are prescribed for the management, supervision, and monitoring of financial intermediaries.
Bank governance: National measures
Besides the three international Basel norms discussed above, banks follow other guidelines prescribed in the various Acts and Regulations in their respective countries.
In Bangladesh, requirements for the financial reports of banks, non-bank financial institutions (regulated under the Financial Institution Act) and various companies are quite reasonable. The disturbing part is that these requirements are not properly complied with by various institutions. This means that the implementation (enforcement and compliance) of rules and regulations is the ‘Achilles’ heel’. Despite supervision and monitoring by the regulatory bodies such as the BB and the Bangladesh Securities and Exchange Commission (BSEC), serious mismanagement and malpractices have occurred in the banking sector as well as in the capital market.
The government of Bangladesh promulgated the Financial Reporting Act (FRA Act) in September 2015. Under the aegis of the FRA Act, the Financial Reporting Council (FRC) started functioning in the middle of the year 2017. The FRC is empowered to cancel the registration of auditors and take punitive actions for fabricating audit reports. We expect that FRC will be proactive to bring discipline in the banking sector.
With a view to strengthening good governance in the financial sector, especially in the banking sector, the BB embarked on several financial-sector reforms over the years. A large number of homegrown reforms have already been taken and some are underway. The BB attempted to strengthen the legal framework of the financial sector, bring in dynamism, extend autonomy to the central bank, combat money- laundering offences, and stop terrorism financing.
There are several other prudential norms of the BB and others related to the Basel Guidelines and the guidelines of various Acts of Bangladesh. Another important aspect is the management norms, which concern the fit and proper test for CEOs and directors of a bank, restrictions on the composition and functions of the Board of Directors. Banks have been directed by the BB and the BSEC to include three independent directors on the Board of Directors. Audit Committees for all banks were mandated with clear guidelines, and TORs and an early warning system (EWS) was introduced. The Core Risk Management Guidelines on major risks were introduced quite some time back and credit-risk assessment by External Credit Assessment Institutions (ECAI) had been recommended for all commercial banks.
However, in recent times, we have seen that many of these prudential and management norms are not followed by banks. There are several privately owned banks where a number of family members are on the Board of Directors, which is contrary to the notion of good corporate governance.
Furthermore, the financial reports in some cases, mainly the audited ones, have been manipulated and facts concealed. The auditors as independent examiners have failed and worked with corrupt management. Some of the audit firms have been blacklisted by the BB. The FRC has also identified faulty audit reports.
Governance failure and political connections
Perfect examples are the Hallmark, Crescent Group, Bismillah Group scandals involving several state-owned banks and the recent S Alam Group’s loan scams involving several private commercial banks. All occurred due to a lack of both transparency and accountability. Both the borrowers and the officials colluded in a non-transparent manner and siphoned off huge amounts of public money.
Politically connected influential peoples were involved in almost all financial scams. Unsurprisingly, The New York Times finds, “Part of the explanation for this [scam] is poor governance by the banks’ boards, but the main culprit is the country’s culture of [political] patronage”. Political consideration has allegedly been the main factor in the case of S Alam Group’s scams. Bank management, loan defaulters and scammers are untroubled because of their political connections.
Thus, those who are responsible have not yet been subjected to administrative and legal actions. A High Court bench on December 4, 2022 directed the authorities to probe the alleged loan scams in Islami Bank, Social Islami Bank and First Security Islami Bank. The Anti-Corruption Commission, the BB, the Bangladesh Financial Intelligence Unit, and the Criminal Investigation Department of Police were asked to submit probe reports to the court by April 5.
In fact, bank management get “perverse incentives” and the honest and dedicated people working in the same bank and elsewhere are pushed back into oblivion, as the Gresham’s law in economics states, “bad money drives out good”. The lack of accountability of bank directors and bank-management personnel for any wrongdoing has resulted in repeated scams and corruption in the banking system.
The bailing out of the troubled banks by the BB creates the classic case of moral hazard. The New York Times reported that the six state-owned banks were recapitalised to the tune of about $640 million for fiscal year 2014 and, more than $700 million for fiscal year 2015.
Since the bank managements know, the banks will be bailed out using public or tax-payers’ money or simply by the BB printing money, they do not have any incentive to ensure their banks’ stability or financial health. Instead, it creates a perverse incentive for corrupt behaviour to benefit through loan scams.
The way forward
One of the main challenges for the Bangladesh’s banking sector is to ensure good corporate governance. Strong actions have to be taken by the concerned regulatory bodies, namely, the BB, the FRC and the BSEC. The Institute of Chartered Accountants of Bangladesh (ICAB) and the Institute of Cost and Management Accountants of Bangladesh (ICMAB) both have the responsibility of ensuring good and honest practices by the professional accountants, who are integral parts of good corporate governance.
To balance the objectives of good governance and ensure compliance with regulations, three major steps are necessary: (a) a strong and independent central bank with more focus on core banking issues (b) a well-thought-out set of prudential and management norms of the central bank that are not subject to frequent changes due to external political/administrative pressure as well as ensuring full compliance of norms by the banks and financial institutions and (c) a system of prompt corrective actions for management of crises and for legal/administrative action against persons responsible for crises in a particular bank or in the banking ‘system’ as a whole.
It is pertinent to mention that a balance must be made between the regulation and independence of a bank. This means that banks should neither be overregulated nor should they be left alone to enjoy complete freedom, which often results in banking disasters. It is important to keep in mind what financial regulation is meant to achieve. The most important objective is to protect depositors, investors, the general public and the real economy (real goods and services) as a whole.
The second rationale for regulation is to minimise the domino effect of the systemic risks of the financial institutions which destroy the foundation of economic activities, resulting in a loss of real output, lower growth, higher unemployment and reduction in human welfare. Good governance in the banking sector must be emphasised in our country, especially in the present context of the crisis in the banking sector. Transparency and accountability have recently become an issue of greater concern with revitalised importance in the context of public and private responsibility of managing banks.
Transparency is necessary to ensure accountability among the major group of participants in financial markets: borrowers and lenders; issuers and investors; and national authorities and international financial institutions. Transparency and accountability are mutually reinforcing. Transparency enhances accountability by facilitating monitoring, and accountability enhances transparency by providing an incentive for agents to ensure that the reasons for their actions are properly disseminated and understood.
In sum, good accountability and proper transparency of all financial transactions have to be ensured. The “political will” is essential to achieve success in all these activities.
Dr. Salehuddin Ahmed is Former Governor, Bangladesh Bank (Central Bank), and currently Professor, Business School, BRAC University. Dr. Salehuddin Ahmed has Masters and BA (Honours) degrees in Economics from Dhaka University and a Ph.D. degree from Canada’s McMaster University. He joined the Pakistan Civil Service in 1971 and served in various capacities in the field of administration for the Government of Bangladesh. A progressive thinker, Dr. Salehuddin has authored more than 80 books, reports and journal articles which have been published at home and abroad.
